Tuesday, 19 August 2008

Advantages and Challenges to use Standard Cost in Manufacturing environment

One of the greate advantage of Standard Cost is Standard cost not tied to time factor. Thus, cost of manufactured items can be calculated at any time based on the predetermined standard cost. If actual cost is used (eg. average cost), time factor is very important in determining the actual production cost. Let's consider the following example, you have received raw materials from suppliers and used the materials to produce finished goods but not yet received invoice from supplier. Without the purchase invoice from supplier, you won't be able to get the actual production cost because the actual raw material cost is not known yet. The production order is posted with an estimated cost first. After purchase invoice is received from supplier, you need to post the invoice and run adjust cost to recalculate the actual production cost, then only you can get the actual production cost.

Determining the initial standard cost and how often to update the standard costs is a very challenging tasks and a lot of effoerts are required to keep the standard cost up to date. Another problem with Standard Cost is Standard cost cannot accurately determine the cost of the item produced if the material cost fluctuates considerably.